Format: Microsoft Word File Part 1 State some of the purposes of finance Give an example of a risk and return relationship Part 2 – Interest Rate You have just received a bonus of 15,000 euros and have decided that you want to invest the money

Format: Microsoft Word File

Part 1

1. State some of the purposes of finance
2. Give an example of a risk and return relationship

Part 2 – Interest Rate

You have just received a bonus of 15,000 euros and have decided that you want to invest the money. After discussing your options with your bank, you have narrowed it down to two options:

1. A savings account that provides 7% simple interest annually.
2. A savings account that provides 6.25% compounded interest annually.

Assume that the deposit is made in year 0 and payments are made at the end of periods with first payment end of year 1.

Answer the following:

1. What is the difference between simple and compounded interest?
2. You have decided to leave the money in the account for 12 years. Which option should you

choose?
3. In which year does option B become more favorable than option A?

Show your calculations

Part 3 – Capital Budgeting

Great Comfort Inc. are producing high end furniture in the USA and are looking to expand their operations. They have analyzed their opportunities and are currently considering two potential ways of expanding either in South America or in China. They are only able to choose one of the two markets.

If they choose to expand in South America, they expect to have to invest USD300 million in a plant, which they expect would yield a yearly return of USD45 million for the next 15 years.

If they instead choose to expand in China, they expect they would have to invest USD370 million, which would return USD25 million yearly for the first 4 years, followed by a yearly return USD60 million for the following 5 years and finally a yearly return of USD90 million for the last 6 years.

Assume that the investment is made in year 0 and payments are made at the end of periods with first payment end of year 1.

Answer

the following:

1. Visualize the stream of cash flows for each investment opportunity.
2. Great Comfort Inc. demands a payback period of maximum 9 years. Calculate the payback

period for both investment opportunities. Do they live up to the requirement? According to

this, which is the preferred option?

3. Great Comfort Inc. has a discount rate of 7%. Calculate the Net Present Value (NPV) of both

investments and state which is the preferred option in this case.

4. Calculate the Internal Rate of Return (IRR) for both opportunities and comment on what this

tells us about the options.

5. What are some disadvantages of the Payback Method?